Global equity roundtable: Part one

Peter Moeschter, executive vice-president and portfolio manager with Templeton Global Equity Group, Franklin Templeton Investments. A value manager, Moeschter runs both EAFE (Europe, Australasia and Far East) and global portfolios for retail and institutional clients.

Michael Hatcher, head of global equities and director of research at Trimark Investments, a division of Toronto-based Invesco Canada Ltd. A value manager, Hatcher’s extensive responsibilities include Trimark Europlus and Trimark Global Fundamental Equity.

Matt Moody, vice-president, investment management and a member of the Mackenzie Ivy team at Mackenzie Investments. The team’s wide range of mandates includes Mackenzie Ivy Foreign Equity and Mackenzie Ivy European Class. The Mackenzie Ivy team seeks to buy high-quality businesses and not overpay for them.

Q: After a strong performance in 2013, the MSCI World Index, which represents 23 developed countries, has put on a more muted showing since the beginning of the year to its recent close. The U.S. equity market has substantially outperformed most of the other leading markets in this benchmark index. Please discuss.

Moeschter: The global financial crisis affected countries in different ways and there were differences in how they dealt with the challenge. The United States has bounced back a little more quickly, perhaps due to its more accommodative monetary policies. It addressed the issues more quickly than Europe, which took the tough-love approach. Germany could not give in too early and simply underwrite the rest of Europe. It needed countries like Spain, Portugal, Ireland, Italy and, to a lesser extent, France, to undertake austerity measures and fix the underlying problems. In the last couple of years, the European Central Bank has been more willing to help out. In all, the recovery has been slower in Europe. It remains fragile, but it’s there.

Q: What about stock valuations?

Moeschter: We find them lower in Europe than in the United States, and as value managers, this has led us there. It’s stock-specific, but we’re still overweight Europe in our global portfolios. There is the potential for European valuations to catch up in the next three to five years, our time horizon. We think that many of these businesses have a lot of earnings upside.

Moody: We’re slightly overweight Europe in Mackenzie Ivy Foreign Equity and for largely the same reasons. The performance of the global equity market year-to-date has been fairly good in the context of uninspiring economic progress. Over the last number of years, there has been a difference between the economic fundamentals and the stock-market performance. That has persisted into this year. We started from a very low base, but are almost six years into a bull market in stocks. Meanwhile, the main economies have been struggling in the aftermath of the global financial crisis.

It hasn’t been plain sailing in the United States, which has undertaken substantial fiscal and monetary stimulus to achieve the progress so far. All is far from rosy there. Europe is in the ongoing process of a tough recovery. European equities have underperformed the U.S. equity market. Like the others here, we’re bottom-up stock pickers. The valuation of high-quality European stocks seems to be better on a relative basis compared to other regions and better than it used to be on an absolute basis.

Hatcher: We have about 20% of Trimark Global Fundamental Equity in Europe. The global economy is just going to muddle along. That has been the case for the last four to five years. What got us into the global financial crisis was the build-up of a tremendous amount of leverage, over a long period of time. It’s going to take a long time to get that leverage down. I don’t see a clear path to Utopia any time soon. But things are marginally getting better across the world. I would expect to see that continue over the next three to five years.

Many of the companies that I own in both portfolios are global in scope. If I look at my list of the next-best ideas for the global fund, the stocks are evenly balanced between U.S.-based companies and European-based companies. I don’t find a lot of difference between those two markets.

Q: Using MSCI country statistics to recent close, Europe was trading at a price-earnings multiple of 16.8 times versus the United States at 19.3 times. The MSCI World Index was trading at a P/E multiple of 18.1 times.

Hatcher: The European Index doesn’t represent the same quality of companies as does the U.S. index. So the valuations would even out a little.

Q: What are your weightings in U.S. stocks in your global funds? The MSCI World Index had a weight for the United States of 57.7%, at recent count.

Moeschter: The U.S. market is just over 35% of our global portfolios. We have found some good value in the U.S. equity market, but have found better value elsewhere.

Hatcher: Trimark Global Fundamental Equity currently has slightly less than 49% in U.S. equities.

Moody: At the end of October, Mackenzie Ivy Foreign Equity had a U.S. weighting of 45%. If you take account of the fund’s cash, the United States represented 53% of our equity weight, making for a modest underweight. The strong performance of the U.S. equity market in the last few years has resulted in the valuation of some of our holdings becoming less attractive, so some have been trimmed.

Q: Looking at your European funds, Trimark Europlus and Mackenzie Ivy European Class have significant cash weightings. What is this telling us, Michael and Matt?

Hatcher: I am a value manager and am finding valuations to be challenging globally. It’s difficult to find the high-quality businesses trading at the 30% discount to intrinsic value that I’m looking for. We look for companies with strong competitive advantages and moats. We want the companies to have a sustainable return on invested capital and generate significant cash flow. High-quality businesses that trade at 18 or 20, or 22 times earnings, have stretched valuations.

The equity markets have certainly done well over the last three to four years and, as Matt said, the earnings growth has not necessarily been there to match this. The markets are generally fully valued. It’s hard to get overly excited about them. We need to see more power behind the earnings.

Moody: The cash levels in our funds are a by-product of the value that we’re seeing in the stocks that we focus on. Our approach is based on the long term and a selection of high-quality companies that have an identifiable competitive advantage. We don’t want to overpay for these companies. We’re finding it difficult to find high-quality businesses trading at acceptable valuations. At the same time, some of the high-quality businesses that we do own in the funds have run up, often ahead of their earnings growth, and become more expensive. We have a strict valuation discipline and that leads us to trim those names. The result of all this is these elevated cash levels.

Looking at the European fund, we have deployed some of the cash since the end of September. We found some opportunities among the small-to-mid-sized companies. We currently hold 18 companies in this fund and 31 in Mackenzie Ivy Foreign Equity.

Moeschter: We keep our cash levels under 5% of the portfolios. Usually 2% to 3% is our target. We have about 100 names in our global portfolios. We try to find good companies when they’re having some problems and ask how the companies will look in five years. Are the problems fixable? If so, what is the magnitude of the upside on the stock? We like to buy the stocks at a big discount to their long-term value. We are finding opportunities, but we have to dig deeper.

Our European holdings have a global reach, so this reduces the actual European exposure. If the stock is being discounted because it is seen as European, then it might re-rate over a couple of years, because the company is not just Europe.

Hatcher: In Trimark Europlus, companies in the portfolio have some 35% of their revenue base in emerging markets and a little over 30% in Europe. It’s a 27-stock portfolio. It’s a global fund that happens to have companies domiciled in Europe. Trimark Global Fundamental Equity has 65 names.

Moody: In Mackenzie Ivy European Class, we have only two companies of the 18 holdings that operate predominantly in Europe. The rest are global in scope.

Horvitch’s three-part series continues on Wednesday and concludes on Friday.